Recommending Trading Buy on BJFOOD with FD FV of RM2.30 (22% upside) on FY17E PER of 21x. A restructuring to rationalize Kenny Rogers Roasters (KRR) could trigger a positive re-rating, in our view, as a pure Starbucks play. Any recovery of MYR against USD could bode well as 40% of costs of goods sold are denominated in USD. With projected net profit growth of 30%- 23% in FY17E-FY18E, valuation is compelling (17.2x FY17E PER, below -1 SD over 5-year mean) after a 40% fall from the peak.

Value emerging from share price weakness. To recap, we had issued a non-rated report on BJFOOD back in Sept 2014 as we were of the view that the positive benefit of Berjaya Starbucks (BStarbucks) acquisition was already fully factored in its share price then. Thereafter, its share price retreated >40% after reaching a peak of RM3.30 as the modest earnings growth failed to meet optimistic expectations, which might have contributed to the decline and was further exacerbated by EPS dilution due to the enlarged share base (+20.5%) as a result of warrants and ESOS conversion. However, the weakness in share price might provide a good entry opportunity as it is currently trading below -1SD over its 5-year mean and at 24%-32% discount to US-listed Starbucks Corp.

A purer brew in the making? As of 9M16, the Group registered PBT growth of 12.5% to RM28.8m thanks to the full consolidation of BStarbucks (starting 2Q15) which recorded 9M16 Same Store Sales Growth (SSSG) of 4.4%. YTD, the Group has expanded its total number of stores by 12 stores to 374 stores (17 opened, 5 closed) with majority (13 stores) of the expansion focused on BStarbucks. As KRR remains the main drag on BJFOOD earnings growth, we are not surprise if the Group is looking to rationalize the flagging business which has presence in Malaysia and Indonesia. We reckon that loss-making outlets that have slim hope of turnaround should be closed down and the Group may also need to adopt new pricing strategy to improve the appeal of KRR to its customers. Should this anticipation materialise, we believe the losses in KRR will be narrowed and BJFOOD will be a more Starbucks-concentrated F&B company. Besides, we also do not rule out that the Group may dispose KRR if and when opportunities arise and, of course, with a right pricing.

A plus point if MYR recovers. We understand that c.40% of BStarbucks’ cost of goods sold is imported content denominated in USD. Thus, the strengthening of USD in 9M16 had inflated the costs of BStarbucks and hence the slower earnings growth. However, earnings margin moving forward might improve if MYR proves able to strengthen against USD (YTD gain of 3%). According to its annual report, a 10% strengthening in MYR could increase its FY15 net profit by 8%. Hence, we think BJFOOD can also be a viable proxy to the strengthening of MYR as it derives its sales revenue primarily (90%) from Malaysia.

Trading Buy with Fully Diluted Fair Value of RM2.30. Our FD FV of RM2.30 is based on 21x PER FY17E. The valuation implied -0.5 SD over its 5-year mean to reflect the earnings weakness from the lacklustre KRR business. We opine that most of the negatives have been priced in the current valuation (17.2x FY17E PER, below -1 SD over 5-year mean). Hence, the current share price is compelling and attractive for investors seeking exposure in the established brand name and resilient nature of Starbucks.

Source: Kenanga Research - 2 Jun 2016